Series 7, Chapter 2: Fundamentals Of Bonds / Corporate Bonds

Front 1

Bonds (in general)

Back 1

Bonds are debt securities.

Bonds have a coupon rate - predetermined fixed interest rate paid semi-annually, but stated as an annual amount

A point on a bond is equal to 1% of par value or $10.00

A bond has a par value of $1,000 and will return that $1,000 to the investor at maturity

Front 2

Bond - Discount/Premium

Back 2

Bonds can be traded publicly.

Discount - bond's market price is less than the par value ($1,00)

* The capital letter M stands for 1,000

Par - The market price is equal to par value ($1,000)

Premium - The bond's market price is more than the par value ($1,000)

Front 3

Series Bonds

Back 3

Hint: SS in series and in issue

Have different issue dates and usually have the same (term) maturity
-frequently used for projects peformed in various stages

Front 4

Term Bonds

Back 4

An entire issue of bonds that all have the same maturity date

Front 5

Serial Bonds

Back 5

Bonds with one issue date and staggered maturity. Because the maturities are staggered, the principal is paid down gradually which leads to lower interest costs as time passes

Front 6

Balloon Maturity

Back 6

Bonds with a large amount of the issue coming due at or near maturity

Front 7

Sinking Fund

Back 7

Money set aside to pay back a company's bonds, debentures, or preferred stock.

- Think term bonds. Sinking funds normally accompany term bonds

- May be a mandatory debt retirement provision of a bond indenture

-Adds to the safety of the bond / lowers the risk / lowers the yield

Front 8

Funded Debt

Back 8

LONG TERM CORPORATE DEBT. Corporate debt that is due more than one year from the issue date

Front 9

Registered Bonds

Back 9

Bonds that are registered in the investor's name

- All bonds nowadays are issued like this
- Interest is paid directly to the investor by the corporation's paying agent
- principal is sent directly to the owner at maturity by the paying agent

Front 10

Bearer Bonds

Back 10

Are not registered in the investor's name and have interest coupons attached, Clip the coupons and present them at the bank for interest payments.
- Stopped in my birth year (1983)

Front 11

Registered as to Principal Only Bonds

Back 11

These bonds are registered in the investor's name, with coupons attached.

Clip coupons for interest. Principal is sent directly to the investor.

Front 12

Three Categories of Bonds

Back 12

Corporate
Government
Municipal

Front 13

Issuer (CGM)

Back 13

(C) Publicly traded corporation

(G) Federal Government

(M) State and local government

Front 14

Taxation on INTEREST (CGM)

Back 14

(C) Fully taxable at federal, state, and local levels

(G) Fully taxable at federal level, exempt from state and local

(M) Assume tax exempt at all levels unless specifically told otherwise

Front 15

Risk (CGM)

Back 15

(C) Riskiest

(G) Safest - Govt can raise taxes or print money

(M) Middle

Front 16

Coupon Rate (CGM)

Back 16

(C) Highest - investors have to pay taxes at all levels

(G) Middle - investors only pay federal taxes

(M) Lowest - exempt from taxes

Front 17

SEC Registration (CGM)

Back 17

(C) Has to be registered with SEC

(G) Exempt from SEC registration

(M) Exempt from SEC registration

Front 18

Quotation Type (CGM)

Back 18

(C) $ in eighths
ex. 96 3/8

(G) $ in thirty-seconds, but it looks like a decimal
ex. 9.06 = 9 6/32 = $9,187.50

(M) $ in eighths or YTM
ex. 96 3/8 OR 4.75%

Front 19

Basis Points

Back 19

A basis point is equal to 1% of a point. Remember, a point is worth 1% of par value

Front 20

Long Term vs. Short Term Maturities

Back 20

The longer the time until maturity of a bond, the more its price will decline when interest rates go up

When interest rates change:
Short term maturities react the quickest.
Long term maturities react the greatest.

Long term bonds are ruskier than short term bonds.

Front 21

Ranking the Safety of Bonds

Back 21

1) Maturity - shorter bonds are safer

2) Rating or Ranking - AAA, AA, A, BBB

S&P, Fitch, Moody's

Front 22

If Interest Rates...

Back 22

If interest rates are expected to go down...
Investors should invest in long term maturities.

If interest rates are expected to go up....
Investors should invest in short term maturities.

Front 23

How Are Corporate Bonds Traded?

Back 23

Most corporate bonds are traded in the over-the-counter market as dealer/principal transactions.

Front 24

Dealer/Principal

Back 24

The broker is working with their own inventory of securities.

Front 25

Dealer/Agent

Back 25

The broker is working as a middle man to bring two parties together.

Front 26

Corporate Bond Quotes

Back 26

Multiply by ten.

If a bond is quoted @ 96 then...
the bond is trading at $960.00

Front 27

Leveraged Buy-Out

Back 27

Company A is trying to take over Company B by using company B's assets as collateral.

Front 28

Spin-off

Back 28

Corporate divestiture that results in the subsidiary of a company becoming its own company.

Front 29

Trust Indenture Act of 1939

Back 29

THINK CORPORATE BONDS.

Deed of trust that specifies the rights and duties of all parties.

Issuer is required to appoint a trustee. The trustee protects the BOND HOLDERS.

The act does not regulate
- Gov't issues
- Municipal issues
- Private placements
- Unit investment trusts (UITs)

Front 30

Accrued Interest (1 of 2)

Back 30

Uses a 30-day month / 360-day year

Pays up to but not including settlement date

Buyer pays seller for accrued interest

Front 31

Accrued interest (2 of 2)

Back 31

Issuers pay interest payments on the 1st or 15th of the month (twice a year)
ex. Jun 1, Dec 1

To calculate the amount of accrued interest count back from when the bond was bought to the last time interest was paid. If it was paid on the 1st of the month, count 30 days. If it was the 15TH OF THE MONTH COUNT 16 DAYS!

Accrued interest shows up on both the buyer's and seller's confirmation. It's added to the amount the buyer pays and added to the amount the seller receives.

Front 32

Dollar Amount of Accrued Interest

Back 32

Principal x Coupon x Time in Days
_________________________

360

Front 33

Taxes on Accrued intererest

Back 33

On the interest payment following the purchase of a bond, the buyer will deduct the accrued interest from the full interest payment and only pay taxes on the difference.

Say the coupon is $80.00 of a recently bought bond. Mr. Jones paid par plus $15.00 accrued interest. On the interest payment following the buy, Mr. Jones receives his $40 interest payment. He will only report $25 in taxes after taking into account the $15 he paid at time of purchase for accrued interest.

Front 34

Corporate Bonds, Mortgage Bonds

Back 34

Mortgage bonds are debt instruments secured by real property.

Closed-end Mortgage Bond - property cannot be used as collateral for futute loans, unless the subsequent loan(s) are lesser in claim.

Open-end Mortgage Bond - property can be used to secure subsequent loans. All debts will hold EQUAL claims

General Mortgage Bonds - pledges all mortgageable properties of a corporation, but does not name any specific lots.

Front 35

Corporate Bonds, Equipment Trust Certificates

Back 35

Issued by transportation companies to by new equipment.

Collateral is the new equipment. Also called rolling stock because the equipment usually has wheels (Railroad cars, airplanes, etc.)

Trustee holds title to equipment until bonds are paid off.

In event of default, bondholders have first right to equipment titles.

Bonds are usually not callable, and are usually issued in serial form. These bonds rarely default because companies don't want to lose the equipment

Front 36

Collateral Trust Certificate

Back 36

Uses securities of other corporations that the issuer owns - usually a parent company and its wholly owned subsidiary.

Collateral placed on deposit with trustee

Front 37

Guaranteed Bonds

Back 37

Guaranteed by a company other than the issuer

Front 38

Debenture

Back 38

Bond backed only by good faith and credit - unsecured.

Front 39

Subordinated Debenture

Back 39

Debenture bond which holds a lesser claim than other debenture bonds, would be paid only after other debentures are satisfied.

Front 40

Junk Bonds

Back 40

A.K.A. HIGH YIELD BONDS

These are issued by newer companies or those with questionable credit strength

Rated BB or lower or not rated at all

usually MORE VOLATILE than investment grade bond

HAVE HIGHER YIELDS AND LOWER PRICES THAN INVESTMENT GRADE BONDS

Front 41

Fallen Angels

Back 41

Bonds that once were investment grade but have been downgraded.

Front 42

Income or Adjustment Bonds

Back 42

RISKIEST BOND THERE IS

Issued only by companies in deep financial shit.

Income bonds PROMISE to pay interest ONLY IF THE COMPANY MAKES SUFFICIENT EARNINGS and the board declares that interest will be paid

Principal is still due at maturity

These normally trade flat (without accrued interest)

Called Ajustment Bonds when used in a corporate reorganization.

Front 43

Zero Coupon Bonds

Back 43

Sold at deep discounts and pay no interest while the bonds are outstanding.

Since they do not pay interest, they never have accrued interest. Instead they pay "imputed interst" or accretion.

When calculation accretion one would use the purchase date, purchase price, and maturity date, but NOT THE CURRENT MARKET VALUE.

At maturity, the investor receives one lump sum

Prodcue "phantom income" which is taxed. Phantom income a way for the government to tax the accretion. (You pay taxes before you even touch the money)

Purchased by investors who want capital accumulation. Good for investors planning for an event in the future - ex. college for kids.

ZERO COUPON BONDS ARE THE MOST VOLATILE OF ALL FIXED INCOME SECURITIES.

Front 44

Callable Bonds

Back 44

Bonds can be called (redeemed) at the option of the issuer, at a PRE-ESTABLISHED PREMIUM PRICE AFTER A SPECIFIC DATE

Call features are advantageous to issuers, not investors

A low call price is attractive for the issuer, a high call price is not

A call price places a ceiling on the appreciation possibilities of a bond because a callable bond will almost never have a market value higher than the call price. The issuer will call it before that happens.

Everything else is even, a bond with a higher coupon rate is going to be called before one with a lower coupon rate.

Front 45

Call Protection

Back 45

A fixed time period during which a bond can not be called.

Bondholders want interest rates to decline during this period.

Front 46

When a corporate bond is called....

Back 46

1) the bondholder receives a premium

2) Credit worthiness of the company improves because it has less debt.

3) Debt to net worth ratio also decreases and improves (less debt)

Front 47

Notice of Call

Back 47

Before a company can call its bonds. the company must give a "notice of call" During this time an invetor can..

a) Convert the bonds (and sell the common stock he receives)
b) Sell the bonds
c) Wait for redemption

Interest payments stop after a call.

Companies can do a partial call. Bondholders are selected at random for partial calls.
Callable bonds usually trade at a lower price than non callables

Front 48

Ratings of Bonds

Back 48

Credit ratings are assigned to bonds by MOODY'S, STANDARD & POOR'S, AND FITCH ----- NOT A.M. BEST

Front 49

Convertible Bonds

Back 49

Converting a bond is NOT A TAXABLE EVENT. It becomes taxable after you sell the common stock you receive from the conversion.

Front 50

Conversion Price Formula

Back 50

Par Value
-------------- = Conversion
# of shares Price
received